Question

(1+0.03523/1 (1+.04)A2-1 1.02507 2.51% 1.04 1.04-1.0816 1.035 1.035 1.035-1.1087 1.0816 1.02507-1.1087 6-6-3 Future Interest Rates-2nd Example Suppose that you can look into a five-year security witha yield of4%. If the threeyear rate is 3.5%, what is the expected two-year rate in three years (for years four and five) based on the pure expectations theory? 6-7 Macro Factors The Federal Reserve decides to greatly increase the money supply. What is the expected effect on interest rates? Lower interest rates -

Answer 1

Ans: 6-6-3 Future Interest Rates- 2nd Example As per pure expectation theory, the price and interest rate determined on the basis of future expectations of interest rate. 8 Given in Question, 4Five year yield-4% Three year rate-3.5% 5 Expected two year rate-? : 8 Let suppose two year expected rate- X 9 So, as expectation theory, O(1+0.04)A5-1(1+0.35)A3(1+X)A2 1 = 1.21665-1.10872(1+x)^2 2 = 1.21665/1.10872-(1+x)^2 = 1.09735=( 1+x)^2 = square root of 1.09735-(1+x) 1.04754-1+X = x=1.04754-1:0.04754 5 3 Hence, Expected rate - 4 .754%